Inflation is Here (It Always Has Been) Part 1

Remember the Jimmy Carter era, with interest peaking at 21% prime rate, mortgages peaking at 18.5%, money market yields above 12%, gasoline lines, waiting for 8-gallon maximum purchases on alternate days, sweaters in the White House, key locks on commercial thermostats to assure the thermostat police that no one was warm enough or cool enough to be truly comfortable, washers inserted into shower heads to reduce the water flow, low-flush toilets, lower-yet-flush toilets, hostages in Iran, helicopter crashes, oil embargos, and the so-called American “malaise”? I do. In fact, some of these things irritate me to this day.

This “nostalgic” look back is brought to you by the currently-changing inflation picture in this country. The Bureau of Labor Statistics (BLS) is telling us that the Consumer Price Index (CPI) has increased about 1% over the last 12 months, but it is likely to rise in the near future. The Federal Reserve (at least before last week) agreed. For those of you who are able to fog up a mirror, I’ll bet you know that something is wrong with that analysis. Until recently, buying gasoline was a lot of fun, relatively speaking; everything else – not so much! From about $1.59/gallon, the average has risen to $2.02/gallon. Still good, but the trend is unmistakable.

How bad is it? This week, I agreed with Alan Greenspan! Those who know me will understand how rare that is. (Or, perhaps, he agreed with me. That would be even more rare, I suppose.) The former FED Chairman is troubled by low productivity, low-to-negative interest rates, and entitlement funding crowding out investment. As Louie proclaimed in my favorite movie, Casablanca, “Welcome back to the fight.” For most of his Chairmanship, I believed that Greenspan was tone deaf to the needs of the economy and to the people of this country. Perhaps a little distance outside the Beltway has been good for his perspective?

Since the CPI is supposed to be a measure of price increases over time for Americans, it should reflect the actual inflation rate, right? Why do we get cognitive dissonance when we hear numbers like 1% annual inflation? Is it possible that the number is incorrect? We’ll take a good look.

We have all seen inflation over the past few years. Perhaps the true nature of rising prices is best seen at the grocery store. Milk, eggs, bread, meats, it doesn’t matter. Prices are higher, and containers are smaller. I feel lucky that a dozen eggs still contains twelve eggs! What next, a container of ten (you heard it here first)? The price of feeding a family is rising, and rising quickly.

But it doesn’t stop there. Pay your health insurance premium, and check the increase in your deductible and out-of-pocket expenses. Pay your homeowner’s insurance premium; what was it two yeas ago? Buy dog food, pay tuition bills, go to a movie, pay for your cable TV and Internet service, and pretty much anything except gasoline -- all have gone up. Many of them by a LOT! And now gasoline is rising – quickly. Wages and salaries have not kept pace for 30 years, and Social Security recipients have been denied any increase three times since 2010. And don’t even get me started on taxation! What’s up with that?

Simply put, inflation is on the rise. In order to understand why, we need to look at the real definition of inflation. Nobel Laureate monetary economist Milton Friedman said it best, when he put it this way: “[Inflation is] always and everywhere a monetary phenomenon.” By this definition, rising prices are a symptom of inflation, or a result of inflation, rather than the definition of inflation. More money in circulation results in less value per dollar, which means that the purchase of goods and services requires more dollars. Believe me when I say that the U.S. Government printing presses have been running for years. That encompasses both the physical printing press, plus the more clandestine electronic-entry money creator called the Federal Reserve.

John Tamny, an economist and Forbes Magazine contributor, describes inflation as a period in which capital goes on strike. He says that “[R]ather than a measure of prices that change for various reasons that have nothing to do with currency policy, inflation is at its core the painful process by which capital flows to the hard assets of the earth and away from innovative, wage-creating industries.” Tamny recently released a book called Popular Economics. While I know that most people are turned off by the study of economics, I highly recommend Tamny’s new, fresh look at an old topic.

What Tamny describes is an intentional capital flight from goods-and-services-producing purposes to hard assets, such as gold and silver. The reasoning for this shift is anything but crystal clear. Certainly, world economic conditions play a role, but capital markets have a unique forward-looking view of the world. There is an old saying that the stock market looks about 6 to 9 months ahead of the current market trading day. Expectations drive actions, and uncertainty drives expectations. To a large extent, we are subject to uncertainty about politics, the economy, taxes, regulations, wars, terrorism, and a host of other concerns, including local and international in nature.

A second school of thought (more Keynesian) is that rising prices constitute inflation. These people call it “inflation,” regardless of the true definition of the word. They attribute this to high consumer demand, which supposedly leads to shortages and rising prices. This phenomenon is called “demand pull inflation.” I remember, during the Clinton years, when Senator Fritz Hollings was heard to say that “[T]here is too much consuming going on out there.” Clinton himself quipped that he’d like to let you keep more of your own money, but he couldn’t be sure that you’d spend it “the right way.” So much for the widely-promised middle class tax cut. What a condescending comment that was!

But I digress. From our major problems understanding inflation, let’s explore the ability of the government to manipulate our thinking. From there, it is a short hop to regulating our behavior. How do they do it? For one, with the Consumer Price Index, or CPI.

As a measure of the increasing cost of living, the CPI is dismal. By design. Here’s the classic example. The largest component of the CPI (about 33%) is the cost of shelter, which is computed in the most obscure, arbitrary way anyone could ever imagine. “Changes in the cost of shelter are computed by asking homeowners how much rent they would charge if they were to rent their homes today,” according to George Schultze in Forbes Magazine in 2013. How accurate do you think that a sample of average Americans can be, when estimating something for which they are, at best, ill-equipped?

The stated reason that shelter cost is calculated so arbitrarily goes back to the 1980’s, when the government announced that there was not a good month-to-month price measurement for shelter. This was “explained” by the presence of commercial properties in the real estate sales statistics. This is, of course, bunk! At least, it is today.

A little about statistics here would be helpful. Words mean things, and statistics can be used to illustrate a point that most any author wants to make. But definitions cannot be altered – not without a fight from me, anyway. A median home price simply means that there were as many sales above the median as below. It has no bearing on the price of a given home in a given market; it only describes what has sold during the month.

An average price is simply the total dollar sales, divided by the number of homes sold, and is again useless as a price-change measure. The BLS claims that these would not work, and they are correct. However, such a measure does exist, and BLS ignores it. The Case-Shiller home price index is a readily available home price tracking index that holds constant the inputs. In other words, it compares the same properties over time to determine price changes. And it is free.

Why, then, does the government not use the readily-available Index to calculate the changes in shelter costs? Is it in their best interests to obfuscate? Next week I will explore inflation, real and reported, and I promise you that it isn’t a pretty picture.